Essay about Cost of Capital at Ameritrade

1002 WordsJun 13th, 20135 Pages

In mid-1997, Joe Ricketts, Chairman and CEO of Ameritrade Holding Corporation, wanted to improve his company’s competitive position in deep-discount brokerage1 by taking advantage of emerging economies of scale. The success of the strategy required Ameritrade grow its customer base. The growth would require substantial investments in technology to improve service and capacity, and in advertising, to increase customer awareness. The strategy would require large expenditures relative to Ameritrade’s existing capital. In order to evaluate whether the strategy would generate sufficient future cash flows to merit the investment, Ricketts needed an estimate of the project’s risk.
Company Background
Formed in 1971, Ameritrade has been a pioneer…show more content…

Interest revenues were generated by charging customers on debt balances maintained in brokerage accounts and the investment of customers’ cash segregated in compliance with federal regulations in short- term marketable securities. Interest revenues were offset by interest payments to customers based on credit balances maintained in brokerage accounts.
Virtually all of Ameritrade’s revenues were directly linked to the stock market. Investors generally curtailed trading activity and their borrowing in response to sustained downward movements in the stock market. For example, trading activity declined more than 20% in 1988 following the stock market crash of October 19, 1987. A substantial decline in the stock market could therefore lead to a steep decline in Ameritrade’s brokerage commissions and net interest revenues.
Full-service brokers were less sensitive to market movements than deep-discount brokers like Ameritrade. Full-service brokers received asset management fees, which partially shielded the revenue stream from market declines. Moreover, most full-service brokerage firms such as Merrill Lynch diversified their revenue stream by engaging in investment banking activities such as mergers and security underwritings.
Planned Investments and the Cost of Capital
Ricketts planned to grow Ameritrade’s revenues by…

Ameritrade is formed in 1971, and is a pioneer in the deep-discount brokerage sector.
In march 1997, Ameritrade raised $22.5 million in an initial public offering. Management at Ameritrade is considering substantial investments in technology and advertising, but is unsure of the appropriate cost of capital.
Estimating the cost of capital
1. Since we do not have the beta for Ameritrade, we need to find comparable firms for which we could compute the betas. There are several candidates in the…

Cost of Capital at Ameritrade
What factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why?
Mr. Ricketts believes that his role as CEO is to maximize shareholder value by accepting any project whose expected return on investment is greater than the cost of capital. Therefore, the main factors that Ameritrade management should consider are the expected return on investment for the project, and how this compares to the project’s…

201-046
Cost of Capital at Ameritrade
Exhibit 1 Consolidated Annual Income Statements for the Fiscal Year Ending in September
1997 Net Revenues Transaction Income Net Interest Other Total Net Revenues Expenses Excluding Interest Employee Compensation Commissions and Clearance Communications Occupancy and Equipment Cost Advertising and Promotion Provision for Losses Amortization of Goodwill Other Total Expenses Excluding Interest Income Before Income Taxes Taxes Net Income EPS Shares Outstanding…

Cost of Capital
Definition: cost of capital is the rate of return that a company must earn on its project investments to maintain its market value and attract funds. The cost of capital to a company is the minimum rate of return that is must earn on its investments in order to satisfy the various categories of investors, who have made investments in the form of shares , debentures and loans. The cost of capital in operational terms refers to the discount rate that would be used in determining the…

years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis’s cost of capital. Jones has provided you with the following data, which she believes…

Part I. Estimating the cost of capital is challenging, because the cost of capital effectively puts a price on the risk of the project. If we know the risk, it would not be risk, it would be certainty. Inherently, then, there is a philosophical challenge with finding a good estimate of the firm's cost of capital. It is assumed, however, that the market view of the firm is a fairly accurate reflection of the company's risks. The main techniques for estimating the cost of capital, therefore, are market…

it so important to estimate a firms cost of capital?
The WACC (weighted average cost of capital) is a percentage figure resulting from a calculation method by which the adequate cost of capital of a firm is expressed. It considers the composition of a company’s funding, be it debt or equity. A corporation whose source of funding is equity by 100 percent will have a WACC equal to the cost of equity. By contrast, a levered company will have to reflect the cost of debt as well. The WACC takes their…

average cost of capital and marginal cost of capital. We have seen that the weighted average cost of capital is the basis for the 10% discount rate that was used to evaluate the project. The weighted average cost of capital reflects the firm's cost of capital, and that includes both debt and equity. This is a more accurate figure to use in the calculation of a project's value than the marginal cost of capital.
The marginal cost of capital is the cost to the firm of an additional unit of capital (Investorwords…

Analyzing Capital Structures and Costs of Capital
TESCO
Tesco is a British retail magnate trading at the London Securities Exchange. The company had several capital and quasi-capital transactions with providers of finance during the fiscal year 2008; had the effect of altering their capital structure and changing their Weighted Average Cost of Capital. During this financial year, Tesco was financed by retained profits, long and medium-term debts, capital market issues, commercial papers, bank borrowings…